When migrants send home part of their earnings in the form of either
cash or goods to support their families, these transfers are known as
workers' or migrant remittances. They have been growing rapidly
in the past few years and now represent the largest source of foreign
income for many developing countries.

It is hard to estimate the exact size of remittance flows because many
transfers take place through unofficial channels. Worldwide, officially
recorded international migrant remittances are projected to exceed $232
billion in 2005, with $167 billion flowing to developing countries. These
flows are recorded in the balance of payments; exactly how to record them
is being reviewed by an international technical group. Unrecorded flows
through informal channels are believed to be at least 50 percent larger
than recorded flows (see Picture This on page
44). Not only are remittances large but they are also more evenly distributed
among developing countries than capital flows, including foreign direct
investment, most of which goes to a few big emerging markets. In fact,
remittances are especially important for low-income countries.

How is the money transferred?

A typical remittance transaction takes place in three steps. In step
1, the migrant sender pays the remittance to the sending agent using cash,
check, money order, credit card, debit card, or a debit instruction sent
by e-mail, phone, or through the Internet. In step 2, the sending agency
instructs its agent in the recipient's country to deliver the remittance.
In step 3, the paying agent makes the payment to the beneficiary. For
settlement between agents, in most cases, there is no real-time fund transfer;
instead, the balance owed by the sending agent to the paying agent is
settled periodically according to an agreed schedule, through a commercial
bank. Informal remittances are sometimes settled through goods trade.

The costs of a remittance transaction include a fee charged by the sending
agent, typically paid by the sender, and a currency-conversion fee for
delivery of local currency to the beneficiary in another country. Some
smaller money transfer operators (MTOs) require the beneficiary to pay
a fee to collect remittances, presumably to account for unexpected exchange-rate
movements. In addition, remittance agents (especially banks) may earn
an indirect fee in the form of interest (or "float") by investing
funds before delivering them to the beneficiary. The float can be significant
in countries where overnight interest rates are high.

Why are remittances helpful?

Remittances are typically transfers from a well-meaning individual or
family member to another individual or household. They are targeted to
meet specific needs of the recipients and thus, tend to reduce poverty.
In fact, World Bank studies, based on household surveys conducted in the
1990s, suggest that international remittance receipts helped lower poverty
(measured by the proportion of the population below the poverty line)
by nearly 11 percentage points in Uganda, 6 percentage points in Bangladesh,
and 5 percentage points in Ghana.

How are remittances used? In poorer households, they may finance the
purchase of basic consumption goods, housing, and children's education
and health care. In richer households, they may provide capital for small
businesses and entrepreneurial activities. They also help pay for imports
and external debt service, and in some countries, banks have been able
to raise overseas financing using future remittances as collateral.

Remittance flows tend to be more stable than capital flows, and they
also tend to be counter-cyclical—increasing during economic downturns
or after a natural disaster in the migrants' home countries, when
private capital flows tend to decrease. In countries affected by political
conflict, they often provide an economic lifeline to the poor. The World
Bank estimates that in Haiti they represented about 17 percent of GDP
in 2001, while in some areas of Somalia, they accounted for up to 40 percent
of GDP in the late 1990s.

Is there a downside?

There are a number of potential costs associated with remittances. Countries
receiving migrants' remittances incur costs if the emigrating workers
are highly skilled, or if their departure creates labor shortages. Also,
if remittances are large, the recipient country could face an appreciation
of the real exchange rate that may make its economy less competitive internationally.
Some argue that remittances can also create dependency, undercutting recipients'
incentives to work, and thus slowing economic growth. But others argue
that the negative relationship between remittances and growth observed
in some empirical studies may simply reflect the counter-cyclical nature
of remittances—that is, the influence of growth on remittances rather
than vice-versa.

Remittances may also have human costs. Migrants sometimes make significant
sacrifices—often including separation from family—and incur
risks to find work in another country. And they may have to work extremely
hard to save enough to send remittances.

Can high transaction costs be cut?

Transaction costs are not usually an issue for large remittances (made
for the purpose of trade, investment, or aid), because, as a percentage
of the principal amount, they tend to be small, and major international
banks are eager to offer competitive services for large-value remittances.
But in the case of smaller remittances—under $200, say, which is
often typical for poor migrants—remittance fees can be as high as
10–15 percent of the principal (see table).

Transfer costs
Remittance fees could be reduced significantly if they were converted
to a flat fee instead of a percentage of the principal transferred.

Approximate
cost of remitting $200 (percent
of principal)

Belgium–Nigeria
Belgium–Senegal
Hong Kong–Philippines
New Zealand–Tonga ($300)
Russia–Ukraine
South Africa–Mozambique
Saudi Arabia–Pakistan
UAE–India2
United Kingdom–India
United Kingdon–Philippines
United States–Colombia
United States–Mexico
United States–Philippines

Cutting transaction costs would significantly help recipient families.
How could this be done? First, the remittance fee should be a low fixed
amount, not a percent of the principal, since the cost of remittance services
does not really depend on the amount of principal. Indeed, the real cost
of a remittance transaction—including labor, technology, networks,
and rent—is estimated to be significantly below the current level
of fees.

Second, greater competition will bring prices down. Entry of new market
players can be facilitated by harmonizing and lowering bond and capital
requirements, and avoiding overregulation (such as requiring full banking
licenses for money transfer operators). The intense scrutiny of money
service businesses for money laundering or terrorist financing since the
9/11 attacks has made it difficult for them to operate accounts with their
correspondent banks, forcing many in the United States to close. While
regulations are necessary for curbing money laundering and terrorist financing,
they should not make it difficult for legitimate money service businesses
to operate accounts with correspondent banks.

An example where competition has spurred reductions in fees is on the
U.S.–Mexico corridor, where remittance fees have fallen by 56 percent
from over $26 (to send $300) in 1999 to about $11.50 now. In addition,
some commercial banks have recently started providing remittance services
for free, hoping that would attract customers for their deposit and loan
products. And in some countries, new remittance tools—based on cell
phones, smart cards, or the Internet—have emerged.

Third, establishing partnerships between remittance service providers
and existing postal and other retail networks would help expand remittance
services without requiring large fixed investments to develop payment
networks. However, partnerships should be nonexclusive. Exclusive partnerships
between post office networks and money transfer operators have often resulted
in higher remittance fees.

Fouth, poor migrants need greater access to banking. Banks tend to provide
cheaper remittance services than money transfer operators. Both sending
and receiving countries can increase banking access for migrants by allowing
origin country banks to operate overseas; by providing identification
cards (such as the Mexican matricula consular), which are accepted by
banks to open accounts; and by facilitating participation of microfinance
institutions and credit unions in the remittance market.

Can governments boost flows?

Governments have often offered incentives to increase remittance flows
and to channel them to productive uses. But such policies are more problematic
than efforts to expand access to financial services or reduce transaction
costs. Tax incentives may attract remittances, but they may also encourage
tax evasion. Matching-fund programs to attract remittances from migrant
associations may divert funds from other local funding priorities, while
efforts to channel remittances to investment have met with little success.
Fundamentally, remittances are private funds that should be treated like
other sources of household income. Efforts to increase savings and improve
the allocation of expenditures should be accomplished through improvements
in the overall investment climate, rather than targeting remittances.
Similarly, because remittances are private funds, they should not be viewed
as a substitute for official development aid.

For further information
see Global Economic Prospects 2006: Economic Implications
of Remittances and Migration,World Bank; and